This is not good news for finance minister Pranab Mukherjee as his primary objective is to make the 2011-12 Budget as non-inflationary as possible. That is the best tax break he can give the Aam Aadmi. But the sudden spurt in global crude by over $20 in just a couple of weeks will upset the finance ministers expenditure calculations by at least 1% of GDP( R60,000 crore), if one takes the cumulative impact of higher global oil prices on government finances. This will additionally create inflationary expectations across the economy. How will the government insulate the common man from such a hostile set of global and local events
This then will be the main worry of Pranab Mukherjee as he rises to present the annual Budget in Parliament on Monday.
In the short run, Pranab Mukherjees options are indeed very limited. Short-term non-inflationary measures could include lowering of petroleum taxes. Import duty of 5% on crude could be done away with to reduce the impact of global oil prices. Since customs and excise duty collections have been very robust (at over 40%) in 2010-11 so far, there could be a case for moderating these taxes on oil products.
However, Mukherjee cannot forgo too much on taxes as he is committed to improving the fiscal deficit target to 4.8% of GDP in 2011-12.
The markets are seeing this as a very important signal for maintaining a positive environment for interest rates in the economy. If the fisc continues to be as expansive as in the previous two years, then government bond yields could head north, signalling an even more hostile interest rate environment. That will be bad news for the stock markets in general and bank stocks in particular.
Post the global meltdown in 2008, it is Indias banking sector that led the stock market recovery, and reinforced the faith of global investors. The banking sector has by and large been the mainstay of Sensexs stability ever since. However, an expansive fisc could make the interest rate environment unstable and spell trouble for the banks as well as industry which may face the prospect of crowding out.
So balancing growth with inflation, with a much greater emphasis on inflation control, will be the finance ministers key challenge. The best bet for Mukherjee appears to be to send some strong medium term non-inflationary reform signals and then pray these might dampen inflation expectations. A Goods and Services Tax (GST) road map will be non-inflationary in the medium term as it will knock off some 7 to 8% of the total indirect tax incidence at the centre and state level. This also has the potential to scale up revenue generation, thereby addressing fiscal consolidation. Other supply side reform signals like encouraging more investments in agriculture infrastructure, mining etc can also lower inflation expectations from the supply end.
The finance minister could also partly address the inflation problem by increasing the income tax exemption limit for the Aam Aadmi. But then over 80% of the population is not affected by the tax changes as they are too poor to attract tax liability. For them the proposed food security programme can act as an antidote to inflation. MNREGA can be inflation indexed as has been proposed. But then all this will cost money and can be executed only if expenditures are also tightly targeted. Does the UPA have the will to meet this governance deficit